Capital Allocation Trends At MEGAIN Holding (Cayman) (HKG:6939) Aren't Ideal

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating MEGAIN Holding (Cayman) (HKG:6939), we don't think it's current trends fit the mold of a multi-bagger.

What Is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for MEGAIN Holding (Cayman), this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.12 = CN¥45m ÷ (CN¥404m - CN¥39m) (Based on the trailing twelve months to December 2022).

Thus, MEGAIN Holding (Cayman) has an ROCE of 12%. That's a pretty standard return and it's in line with the industry average of 12%.

See our latest analysis for MEGAIN Holding (Cayman)

Historical performance is a great place to start when researching a stock so above you can see the gauge for MEGAIN Holding (Cayman)'s ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of MEGAIN Holding (Cayman), check out these free graphs here.

So How Is MEGAIN Holding (Cayman)'s ROCE Trending?

On the surface, the trend of ROCE at MEGAIN Holding (Cayman) doesn't inspire confidence. To be more specific, ROCE has fallen from 55% over the last five years. However it looks like MEGAIN Holding (Cayman) might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, MEGAIN Holding (Cayman) has done well to pay down its current liabilities to 9.6% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line On MEGAIN Holding (Cayman)'s ROCE

Bringing it all together, while we're somewhat encouraged by MEGAIN Holding (Cayman)'s reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 21% over the last year, investors may not be too optimistic on this trend improving either. Therefore based on the analysis done in this article, we don't think MEGAIN Holding (Cayman) has the makings of a multi-bagger.

If you'd like to know more about MEGAIN Holding (Cayman), we've spotted 3 warning signs, and 1 of them doesn't sit too well with us.

While MEGAIN Holding (Cayman) isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.